The Traders Guide to Equity Spreads
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Markets can be unpredictable so ensuring you protect against excessive losses is important to your long-term success. With our powerful, award-winning ETX TraderPro platform available for both iOS and Android you can monitor your position on the go and get alerts about your position to help you make better trading decisions. Deciding on the right index to trade When deciding on the index or Indices you would like to trade, it is important that you feel confident in understanding how and why prices move within your chosen market s.
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Protecting your position Risk management is an important part of your trading plan and while research and analysis can give you a feel for market trends, they are not infallible and the market can still move against you. Knowing when to exit the market Once your position is live it is crucial that you monitor price action in your chosen market and note any trends which could be a precursor of future market movement. What is Indices trading? Ready to get started? Open live account Open demo account. Each contract is worth shares.
The reason an investor would use this strategy is simply to protect their downside risk when holding a stock. This strategy functions just like an insurance policy, and establishes a price floor should the stock's price fall sharply. An example of a married put would be if an investor buys shares of stock and buys one put option simultaneously. This strategy is appealing because an investor is protected to the downside should a negative event occur.
At the same time, the investor would participate in all of the upside if the stock gains in value. The only downside to this strategy occurs if the stock does not fall, in which case the investor loses the premium paid for the put option. With the long put and long stock positions combined, you can see that as the stock price falls the losses are limited. Yet, the stock participates in upside above the premium spent on the put.
Both call options will have the same expiration and underlying asset. The trade-off when putting on a bull call spread is that your upside is limited, while your premium spent is reduced. If outright calls are expensive, one way to offset the higher premium is by selling higher strike calls against them. This is how a bull call spread is constructed.
In this strategy, the investor will simultaneously purchase put options at a specific strike price and sell the same number of puts at a lower strike price. Both options would be for the same underlying asset and have the same expiration date.
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This strategy is used when the trader is bearish and expects the underlying asset's price to decline. It offers both limited losses and limited gains. The trade-off when employing a bear put spread is that your upside is limited, but your premium spent is reduced. If outright puts are expensive, one way to offset the high premium is by selling lower strike puts against them.
This is how a bear put spread is constructed.
This strategy is often used by investors after a long position in a stock has experienced substantial gains. This is a neutral trade set-up, meaning that you are protected in the event of falling stock, but with the trade-off of having the potential obligation to sell your long stock at the short call strike. Again, though, the investor should be happy to do so, as they have already experienced gains in the underlying shares. This strategy allows the investor to have the opportunity for theoretically unlimited gains, while the maximum loss is limited only to the cost of both options contracts combined.
This strategy becomes profitable when the stock makes a large move in one direction or the other. An investor who uses this strategy believes the underlying asset's price will experience a very large movement, but is unsure of which direction the move will take. This could, for example, be a wager on an earnings release for a company or an FDA event for a health care stock.
Losses are limited to the costs or premium spent for both options. This strategy becomes profitable when the stock makes a very large move in one direction or the other.
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Note: While we have covered the use of this strategy with reference to stock options, the butterfly spread is equally applicable using ETF options, index options as well as options on futures. Commission charges can make a significant impact to overall profit or loss when implementing option spreads strategies. Their effect is even more pronounced for the butterfly spread as there are 4 legs involved in this trade compared to simpler strategies like the vertical spreads which have only 2 legs.
If you make multi-legged options trades frequently, you should check out the brokerage firm OptionsHouse. The following strategies are similar to the butterfly spread in that they are also low volatility strategies that have limited profit potential and limited risk. The converse strategy to the long butterfly is the short butterfly. Short butterfly spreads are used when high volatility is expected to push the stock price in either direction. The long butterfly trading strategy can also be created using puts instead of calls and is known as a long put butterfly.
The butterfly spread belongs to a family of spreads called wingspreads whose members are named after a myriad of flying creatures. Buying straddles is a great way to play earnings. Many a times, stock price gap up or down following the quarterly earnings report but often, the direction of the movement can be unpredictable. For instance, a sell off can occur even though the earnings report is good if investors had expected great results If you are very bullish on a particular stock for the long term and is looking to purchase the stock but feels that it is slightly overvalued at the moment, then you may want to consider writing put options on the stock as a means to acquire it at a discount Also known as digital options, binary options belong to a special class of exotic options in which the option trader speculate purely on the direction of the underlying within a relatively short period of time Cash dividends issued by stocks have big impact on their option prices.
This is because the underlying stock price is expected to drop by the dividend amount on the ex-dividend date As an alternative to writing covered calls, one can enter a bull call spread for a similar profit potential but with significantly less capital requirement.